Markets Watch Fourth Quarter GDP for Clues About First Quarter Growth

Fourth quarter GDP data Friday should show the best growth pace in nearly two years as well as provide some insights into first quarter growth.

What's Next?

GDP is released at 8:30 a.m. EST, and economists’ consensus is for growth of 3 percent, the best since the 3.8 percent in second quarter, 2010.

Consumer sentiment is reported at 9:55 a.m. There is also an early morning crop of earnings reports, including Procter and Gamble , Ford , Honeywell and Chevron .

Deutsche Bank chief U.S. economist Joseph LaVorgna said in the fourth quarter GDP report, inventories are expected to be a substantial contributor to output, meaning any slowing in the rate of inventory build would weigh on production and first quarter GDP.

LaVorgna said it will also be important to watch final sales, or GDP, less inventories, besides the overall growth number. “We are assuming that current (first) quarter growth slows to around 2 percent before re-accelerating next quarter and into the back half of the year. This is based on two primary factors: First, we expect improving labor market conditions to bolster consumer spending; and second, we are anticipating a snapback in capital spending,” he said in a note.

LaVorgna said the December durable goods report supported that view. The report, released Thursday, showed an increase of 3 percent, more than expected. A measure of business spending, nondefense capital goods, excluding aircraft, rose 2. 9 percent.

LaVorgna said he expects inventories in the GDP report to have expanded at a $45 billion annualized pace in the fourth quarter, compared to the surprise $2 billion decline in the third quarter. This would be the largest increase since the first quarter of 2011.

Pierpont Securities chief economist Stephen Stanley is expecting inventory growth of just $25 billion. “As I see it, firms got really lean in the third quarter, and even though they tried to add inventories relative to the level of sales, they were even leaner at the end of the year. So I think there’s scope for rebuilding and reaccelerating in the beginning of the year,” he said.

Stanley said his view of lower than consensus inventory growth is also why he has higher expectations for first quarter growth of closer to 3 percent, while the consensus is at 2 percent.

Next week will be the first look at first quarter’s January data, with ISM manufacturing data.

Euro Watch

Investors will also be watching the latest from the World Economic Forum in Davos, Switzerland where key European finance ministers will be speaking Friday morning.

The euro gained slightly against the dollar, to 1.3109 Thursday. A successful Italian bond auction helped drive Italian yields lower. The 10-year Italian note saw its yield temporarily slip below 6 percent for the first time since early December but it moved back above 6.2 percent later.

David Gilmore of Foreign Exchange Analytics said investors see the European sovereign crisis as under control for the time being. “People feel the Greece debt swap will get done,” he said. “..I also think the LTRO (liquidity program) is magic fairy dust for the (European) banks, and I think people are responding favorable to the Fed’s ‘talk easy’ policy.”

Stocks drifted up and then down Thursday, losing the high the market was riding from the idea of more Fed easing. The Dow ended at 12,734, down 22, and the S&P 500 lost 7 to 1318.

T3Live.com’s Scott Redler, who watches short term technicals, said now might be a good time to take some profits. He said the S&P failed Thursday at Wednesday’s high of 1328, and that triggered a short term sell signal.

“There was a lot of excitement in the market from the surge higher yesterday following the Fed announcement… combine giddiness with a push-through failure leads to a short term inflection point. After today’s action, it’s prudent to clean up some excess longs and reduce some risks,” he wrote in a note.

What Else to Watch

Also in Davos, Treasury Secretary Tim Geithner speaks on the outlook for the U.S. economy.

Later in the U.S., New York Fed President William Dudley speaks in New York on recession and Fed stimulus at 10 a.m.